Dollar Rally or Dollar Collapse?

The US dollar had a record amount of bears back in September, just as it did earlier this month. While Wall Street is missing a high probability trading opportunity, we see a short-term bullish setup in the dollar.

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Ben Bernanke this week speaks to the Senate Banking Committee just as Alan Greenspan did in 2005. In 2005 Mr. Greenspan made a statement that at the time flew under the radar and didn't capture the public's attention like it probably would if Ben Bernanke made such a statement today.

Greenspan said to the Senate Banking Committee concerning Social Security, "We can guarantee cash benefits as far out and at whatever size you like, but we cannot guarantee their purchasing power." By that statement, Greenspan implied that money can always be printed to pay for benefits at the expense of a devalued U.S. Dollar.

Mr. Bernanke this time around may or may not speak to the specifics of Social Security benefits, but the risks to the U.S. Dollar certainly remain as high as ever.

Given such risks, why then have we actually been bullish on the U.S. Dollar? Simply put, because price and sentiment tells us to be.

What We Think

In our Technical Forecast published 2/10, I laid the groundwork for why the US dollar is currently a good buy. "The U.S. Dollar has already broken out of its downtrend channel and provides a buy signal for aggressive traders in the PowerShares DB Bullish Fund (NYSEARCA:UUP) or in the PowerShares DB 3x Levered Long (NYSEARCA:UUPT)."

That trade has worked out well as the PowerShares DB 3X Levered Long (NYSEARCA:UUPT) is currently in an uptrend from its low point of $19.29 on Feb.1 to $21 this week. Will that uptrend in the U.S. dollar continue?

What Everyone Else Thinks

One of the reasons I'm bullish on the dollar, besides just the technicals, is the overly pessimistic sentiment. The short dollar trade is a crowd favorite, and when trades get popular they're often wrong. This is easily seen from just a few days of headlines which imply a bearish dollar and bullish euro:

"Chinese Yuan to Take First Place from Dollar" – 02/19/13

"Euro Breakup Risk Falls to 5 Year Low" 02/191/13

"Singapore may scrap US Dollar interbank lending rate" – 02/18/13

Every day there are news articles trying to justify the daily swings of the markets, currencies included. Do these headlines and articles really help us decide the direction of the currencies?

In reality news articles really only help us identify the prevailing public sentiment, and that can be a helpful indicator itself.

Contrarian Opinion

There are numerous opinion surveys that reflect the public and investor sentiment on the dollar and other currencies and assets beyond what the news articles reveal to us. Bloomberg, Ned Davis, and Market Vane track a few more standardized gauges of sentiment.

When public opinion as measured by these surveys reaches extremes, a turning point in the asset is usually very near.

Counter-intuitively when opinion hits its most bullish is usually when tops occur and when sentiment is most negative is usually when bottoms occur. Therefore, you should likely take a contrarian approach when investing by doing the opposite of the popular opinion.

In September 2012 negative sentiment in the US dollar hit a depressed level that had not been seen except a few times in the past, which is one of the reasons we suggested in our October ETF profit Strategy Newsletter to go long UUPT on 9/21 @ $19.68; coincidentally just before the dollar rallied 5% as UUPT hit the $21 target less than 2 months later.

Earlier this month, sentiment again hit a similar bearish level that has already sent the dollar up a few percentage points. I expect that sentiment to continue to help propel the dollar higher.

Finally, speculators, who typically are wrong at key turning points, were the shortest they have been since the dollar was trading at its lows in 2011.

All of this adds up to a bullish scenario for the dollar.

What the Chart Reveals

Technically the dollar has formed a bottom with trendline support from 2011 at September's lows and shown in the chart below. This support held again in October, December, and more recently at the turn of the month.

This support along with a change in sentiment from bearish to bullish should keep providing the buyers needed to propel the dollar higher. The $79 price area also is where the Fibonacci correction level resides, likely also attracting buyers and providing support.

Both the UUP and UUPT trades are up, and we maintain our bullishness on them as long as price stays above our identified stop levels, now safely out of harm's way. I will be updating these levels and the price target for the trade in our twice-weekly published Technical Forecast.

Knowing which way the dollar is headed has much larger implications than what appears on the surface due to its highly correlated (and bullying) nature with other assets, especially the stock market. Given the size of the dollar market, it is the proverbial gorilla in the room. In the article found here I discuss currency's importance in the macro and equity environment in more detail.